Healthcare valuation land mine: Avoid it like the plague

Proceed with caution when valuing a business arrangement or transaction between a healthcare entity and physicians. If the valuation includes a consideration of anticipated referrals, the hospital or healthcare system making payments under the arrangement could face huge penalties for making illegal kickbacks to physicians. A recent jury award illustrates this trouble spot.

Devastating penalty: The District Court of South Carolina has just ordered a hospital to pay $237 million for violating the False Claims Act. Earlier this year, a jury found the hospital guilty under the Stark Law and False Claims Act of providing illegal kickbacks to a group of local doctors under part-time employment contracts that the government said paid well above fair market value. Although the deals made no mention of referral fees, the government argued that the excess amount was paid to ensure that they would continue to get those fees for clinical procedures. The hospital argued that it had both legal and fair market value opinions that backed up the appropriateness of the employment agreements. However, the jury disagreed. The case is U.S. ex rel. Drakeford v. Tuomey Healthcare Systems, Inc., C/A No. 3:05-2858-MBS (D. S.C.).

The hospital, a nonprofit, single-hospital system based in South Carolina, plans to appeal the court’s judgment. The hospital’s Form 990 for 2011 showed net assets of $124 million, so a judgment amount of $237 million is devastating.

Complex legal picture: Valuations in the healthcare industry are particularly challenging because they must be done within the context of a complex regulatory framework. Under the federal anti-kickback statute, healthcare providers cannot exchange remuneration in return for referrals of federal healthcare program business. The federal physician self-referral law (the Stark Law) incorporates a similar principle by prohibiting certain physician referrals to entities with which physicians have compensation arrangements.

Physician referrals can show up in a variety of valuation scenarios in the healthcare area. The November issue of Business Valuation Update includes an article that fully explains these scenarios and how valuation analysts can avoid trouble over the referral issue (subscription required).